Attracting Business Without Giving Away the Store

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Each day, memories of the 1990s economic boom grow more remote, replaced by what feels like a permanent era of scarcity. In an effort to show that they are working to create jobs and promote economic activity, state leaders are increasingly turning to tax incentives for economic development. They range from credits, exemptions or deductions — either for specific industries or for companies that agree to hire a certain number of people — to enticements for companies to move to a particular neighborhood.

Every state has at least one such program, and taxpayers invest billions of dollars in them each year, so it’s important that they are having the desired impact. Bad investments leave less money for education, health care, badly depleted infrastructure and other critical needs. Foregoing wise incentive programs, on the other hand, means missing opportunities to create much-needed jobs and tax revenue.

But no state requires policy makers to rely on good evidence when they make decisions about economic-development tax incentives. A new study from the Pew Center on the States aims to get states to inform their future tax-incentive decisions by carefully evaluating their current programs.

The study finds 13 states leading the way when it comes to evaluating these tax incentives, while 12 others show mixed results. But half of the states, as well as the District of Columbia, haven’t taken the basic steps needed to know whether their incentives are effective.

Dueling incentives sometimes create bidding wars in which states seeking to get businesses to relocate or expand within their borders resemble sports franchises in pursuit of Albert Pujols or Peyton Manning. In the heat of battle, it’s too easy for the desire to win to cloud judgments about whether the amount to be invested is worth it.

In 2008, Massachusetts, a state that falls in Pew’s “mixed-results” category, used tax incentives to secure an expansion by the pharmaceutical firm Shire PLC that would create 680 new jobs. The problem was that the cost of the incentives came out to $70,000 for each job created.

A 2010 study by the Pioneer Institute (a public-policy think tank where I’m a senior fellow) revealed a more basic problem: Despite all the money invested in trying to attract companies to Massachusetts, the overall effect of relocation was miniscule. New firms and the growth of existing ones proved to be the real economic engines.

But Massachusetts may be learning its lesson. A Tax Expenditure Commission is currently reviewing the commonwealth’s economic-development incentive programs. Washington, one of Pew’s “leading-the-way” states, has gone even further. In 2006, it began a 10-year review of every tax incentive the state offers.

More states should follow the lead of Oregon, another “leading-the-way” state. Under a new law, all tax credits expire after six years unless lawmakers extend them. Last year, legislative leaders set a cap on incentives, which makes it more likely that policy makers will use performance data to make choices about which incentives to keep, expand, scale back or eliminate.

Public officials’ fiduciary responsibility to taxpayers is never greater than it is when budgets are tight and the margin for error is small. In times like these, it’s critical that state leaders use solid evaluation data to inform decisions that risk the taxpayers’ money.

Also seen in Governing.